This issue of The Idea Farm comes to us from the good folks at Morninstar, who publish a magazine called Morningstar Advisor. In this issue Paul Justice interviews Rob Arnott and Cliff Asness, two titans of the investment world.
An excerpt from Fitting Factors into the Formula:
“Arnott: I guess I’m saying that I’m a believer that the market is 90% efficient and 10% inefficient, and it’s the 10% inefficiency that creates marvelous opportunities to add just a little bit of value for our clients on a reasonably consistent basis for those who have a modicum of patience. Unfortunately, a lot of investors don’t even have a modicum of patience.
I love to use a concrete example to help people viscerally understand this point. Suppose I go to a client and say, “We’ve scanned your portfolio, and we found an investment that you’ve got that’s very popular and beloved. It has its finger on the pulse of the consumer like nobody else. No serious competitors. Lofty growth potential. It’s gotten to be so popular that it doesn’t have a risk premium, so we just dumped it. Apple is gone from your portfolio. We’ve searched the world high and low to find assets that are truly feared and loathed; lo and behold, we found a basket of Spanish and Greek banks. Yes, I know, some of them are going to go to zero, but the ones that don’t go to zero, they’re really cheap. So, we used the proceeds from Apple to buy a basket of Spanish and Greek banks.”
That’s not very comfortable. Do we viscerally believe that it has better than 50/50 odds of winning? I think most investors, if they sat back and thought about it, would say, “Yeah, I think it does have better than 50/50 odds of winning.” But most investors would also quickly say, “But if it doesn’t win in the first year, you’re fired.” And therein lies the challenge.”